At Hollis, we carry out technical assessments for investors, including ESG, to help them maximise the performance and value of their assets. We work with clients on getting their office assets into institutionally investable condition for the next 10–15+ years.

Many thought that strong demand for office space would not return, changed forever by the lockdowns. This has turned out not to be the case; instead, tenant requirements are healthy and have shifted notably towards A-grade offices that are energy efficient and offer amenities that make people want to come in to work.

This, coupled with the looming MEES regulations and refinancing events, has forced investors to consider the value of upgrading their assets in order to future-proof them and bring them in line with institutional standards.

Commercial rented properties will need to achieve a minimum EPC rating of C by 2027, increasing to a B by 2030, or to otherwise prove a valid exemption.

Fundamental changes to non-domestic EPC methodology in June 2022 has had a considerable impact on how EPCs are calculated. Investors should be cautious when making investment decisions or budgeting capex based on EPC prepared prior to when these updates came into effect.

Investors seeking to refinance assets with ratings of D and below will be required to evidence to funders how they intend to improve this over the course of the loan term.

In addition to costs for the improvements, vacant possession of part of the whole of the building may be needed for the construction period. As this has an impact on rental income, very often a project is commenced at the end of the lease term.

On loan refinance, investors may be asked to put more equity in to balance the loan to value ratio; if they haven’t got the equity, they’ll either go to another loan provider or the investor may need to sell—this often results in price chipping because there’s plenty of buyer demand at today’s market price.

A vulnerable asset is created when it is underperforming, and tenant expiries clash with the refinance date. This, in turn, creates an upgrade opportunity, or the chance for an incoming buyer to offer a below-market rate for the property.

Current office investors will be assessing if the highest maximum rental potential for that building can stand that investment. If not, offloading (likely at a loss) may be the only option.

Tenant demand is strong—and they want five- to 10–year leases (with break options) for offices with top amenities, EPC ratings and good governance. There is a healthy tenant audience who will clamour for A-grade premises and the price-tag that comes with it.

Bridging finance can be used to undergo an asset management programme for 12–18 months before cheaper term debt can be secured.

Although some may assume that these EPC milestones will be pushed out, pension funds, for example, cannot take that risk. These institutions will be assessing their portfolios and, in some cases, deem a proportion to be in need of selling down.

We anticipate that within two to three years, 60% of office stock is going to be out of kilter with where the market is. Investors who own one of these assets, or are considering buying one, will need to work towards ensuring it’s in an institutionally tradable state—in line with the optimal market they’ll eventually be selling into.

Pre-refurbishment value, asset improvement costs, and loss of rent (void period) all need to be considered against the value of the improved asset.

It would be prudent for clients to seek advice on the level of additional investment needed to achieve Grade A status. In this sector, EPC B should be the minimum target.

Read the full Arc & Co. Summer Real Estate Lending Report